Ireland must avoid another Greece, but it will be tough

THIS week marks the second anniversary of the decision by the Irish government to step in and give a total guarantee to the Irish banks.

Two years ago this week, after Lehman Brothers collapsed and the international financial crisis accelerated, Anglo Irish Bank in Dublin with its tens of billions in bad property loans reached the brink.

The situation was stark. Either the government stepped in or the bank would have imploded within hours. The alternative for the government would have been to let Anglo Irish collapse immediately and risk the fallout that could have dragged the rest of the Irish banks down with it.

So the government intervened and gave an absolute guarantee to all the Irish banks. Whether it was the right decision has been hotly debated ever since. It will cost the Irish taxpayer tens of billions, and has saddled us with a mountain of debt that will take several generations to clear. Since then the slowdown in the Irish economy has deepened further into recession, and as a result the government's tax revenue has shrunk, leaving us with massive budget deficits.

After being the Celtic Tiger a few years back, we have now turned into one of the economic basket cases of Europe, down there with Greece and Portugal.

The Irish economy has been very ill for several years. If the economy was a patient, its condition over the past few years would have been termed serious. Now it's critical.

Last week Ireland raised another billion or so on the bond market, part of the money we need to borrow every year to pay our day to day bills. The Irish government is spending a third more than it collects in taxes -- the gap between our spending and revenue is around ****20 billion a year. So the government makes regular trips into the bond market to raise money or refinance older bonds that are at the end of their terms.

What was different last week was the bond yield (or interest) that we had to agree to pay to get the money. The rate of interest demanded by investors last week for Irish government 10-year bonds rose to 6.64%, the highest level since we joined the euro at the beginning of 1999 and over 4.3 points more than the 2.3% Germany has to pay for 10-year money.

Borrowing money at that level just doesn't make sense unless you're desperate. If you borrow at more than the rate your economy is likely to grow, you're never going to be able to pay it back.

But we're desperate. So the Irish state is borrowing money at well over 6% because we need the cash to pay our day to day bills for running schools, hospitals and so on.

Why are the money markets making us pay so much? Basically it's because they think there is a more of a risk (even if it's still a low risk) that we won't be able to pay the money back in the future.

The markets don't like the government's failure so far to put a figure on how much the bailout of our banks is going to cost. They don't like that because it makes it harder to judge how much state revenue is going to be swallowed up by our banks. The more cash we have to put into the banks, the less there will be available to pay the bond holders.

Another reason the money markets think we're a bigger risk these days is because we're taking too long to curb state spending and reduce the budget deficit. The longer we have such a huge annual deficit, the more money we have to borrow and the bigger our debt mountain gets.

Which means it will be harder for us eventually to pay all the bond holders back. The risk is higher, so the interest we have to pay (or the yield on the bonds) has gone up.

As I said, the risk of us getting into such a bad situation that we won't be able to redeem the bonds is still very low. If it wasn't we would be paying a lot more than 6% for money.

The government has agreed a program to reduce our deficits with the European Union, and Minister for Finance Brian Lenihan is sticking to that. He cut the deficit by three billion in last year's budget and he intends to do the same this year in the budget in December. In fact he has said that he may cut even more because since our interest bill is now higher we need to cut more to achieve the same deficit reduction target.

Failure to do this will make the money markets even more jumpy about our prospects. So it seems like we are in for a very tough budget this December that will slash state spending and perhaps raise some extra taxes. And it will be the same next year, and the year after that.

The two big problems we face are bailing out our banks and reducing the budget deficit. Of the two, the cost of winding down Anglo Irish Bank and of supporting the other banks by removing their bad property loans and then recapitalizing them with massive amounts of cash has got the most publicity. But the budget deficit is actually the bigger problem.

The cost of the property collapse and the resulting bailout of the banks is astronomical, maybe 50 billion and maybe a lot more than that. But it's a finite figure. It is what it is and we have to deal with that.

The budget deficit, on the other hand, is now adding an annual 20 billion euros to our debt mountain and will go on doing so year after year unless we take drastic action. We have to stick with the program to cut spending and raise taxes to narrow and eventually eliminate the deficit, the gap between spending and tax revenue.

Doing this is going to require a real cut in our living standard which most people here will find very difficult to accept. It’s going to mean drastic cuts in the level of state services and supports that we now take for granted as an advanced western country.

There are vanity projects and programs run by the government that can be axed, like the hundreds of quangos that are on the state payroll. But to make a real impact on the deficit we will have to make reductions in the big spending areas like welfare, health and pay and pension levels for the huge numbers of state workers.

That can’t be done without making a real difference in the lives of a lot of people. Thanks to our crushing recession we now have close to half a million people who are out of work and getting welfare payments that are very generous by global standards. That is a huge cost and these payments may have to be trimmed.

We also may have to do some very unpalatable things like reducing pension levels and automatic entitlements to health services or child support payments to all families.

The pay and pension levels for state workers now account for around one third of all government spending. Unlike in the private sector, these workers and their guaranteed pensions have so far been affected very little by the global meltdown.

At a time when the pay and pensions of many workers in the private sector have been decimated, this cannot continue. So far the government has been too scared of state sector strikes (in schools, hospitals, etc.) to do anything. But we are running out of time … and money.

There is very little public awareness, never mind acceptance, of the drastic cutbacks that face us here in the next few years. So far people are looking for a painless way out.

This explains why recent opinion polls have shown the Labor Party leader Eamonn Gilmore as the most popular choice for the next taoiseach (prime minister). Traditionally the Irish Labor Party has been in third place behind Fianna Fail and Fine Gael.

Its current popularity is due to the fact that Gilmore has been giving the impression that he can solve the current economic mess without widespread drastic cutbacks. It’s ridiculous and dishonest, but people are so desperate they will clutch at any straw.

As the pressure mounts and the December budget looms, the government’s slim majority is starting to look shaky. Already a couple of the independent members of the Dail (Parliament) who support the government are starting to demand special deals for their own areas.

Their attitude is every man for himself on the sinking ship. But that way will bring strikes, protest marches, possible riots and social disintegration.

Avoiding this is the challenge facing our political leadership. So far there is not much sign that our leaders (including the politicians in all parties) are capable of supplying the real leadership that will be necessary.

If that doesn’t happen, the money markets eventually will stop lending to us and then the crisis will reach a climax. The country will either have to be bailed out by the European Financial Stability Facility (which was in action in Greece recently) or the IMF.

Either way the result will be the same -- drastic cuts in pay for state workers, welfare levels and state services will be imposed from outside, cuts at a level that our politicians would never be willing to impose.

We saw what happened in Greece. It’s not likely to happen here -– but it is not beyond the bounds of possibility. We can still avoid it, but time is running out.